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Just a quick note that the New York Times has written an article about two Madoff investors who are suing the SEC for not doing its job. It will likely be a tough case for the investors/plaintiffs to prevail upon because of the doctrine of sovereign immunity (i.e. government agencies cannot be sued for actions made pursuant to their legislative mandate). However, the inspector general’s Madoff report, which in no uncertain terms castigates the SEC, is likely to be the basis of many of the investors’ complaints.

To say that the SEC is or should be embarrassed about the Madoff scandal is an understatement (please see our most recent discussion on the SEC and Madoff). However, we have to recognize that the SEC has always been (and potentially always will be) hampered by a limited government budget. Budget size affects the ability of the SEC to be an effective enforcer in a number of key ways – not the least of which is the SEC’s (in)ability to train and retain staff who are able to understand the nuance and intricacies of the investment management industry. The budget issue may soon become a non-issue if a proposal by Democratic Senator Charles Schumer makes its way through congress. The Schumer proposal would provide the SEC with badly needed additional funding by allowing the agency to collect fees from the institutions it oversees. According to Schumer’s press release, reprinted in full below, “In 2007, though the SEC brought in $1.54 billion in fees, it secured just $881.6 million in funding. Had the agency simply been able to hold onto all the fees it collected, it would have represented a 75 percent increase over the budget it was allotted through the appropriations process.”

We fully stand behind the Schumer proposal and believe that the SEC needs significantly more funding (than it currently receives) in order to do its job effectively. Additional funding is also needed because of the likely increase of the scope of the SEC’s oversight responsibilities. As we have reported before President Obama is calling for increased financial regulation and members of the Senate and Congress have been quick to propose a handful of bills which would completely burden the SEC if it was not appropriated more funds. We also would like to point out that the CFTC has similar budget concerns and should also be appropratiated more funds.

We urge Congress to move forward with the Schumer proposal and to pass a similar bill for the benefit of the CFTC.

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FOR IMMEDIATE RELEASE:
September 3, 2009

IN WAKE OF EXPLOSIVE REPORT ON FAILURE TO CATCH MADOFF… SCHUMER PROPOSES ALLOWING SEC TO KEEP ALL FEES IT COLLECTS IN ORDER TO AFFORD BETTER-TRAINED PERSONNEL—LEGISLATION COULD RESULT IN NEAR-DOUBLING OF AGENCY BUDGET

Schumer Bill Would Treat Investor Protection Agency Like Fed and FDIC, Which are Already Allowed To Keep Fees They Collect

On the heels of an explosive independent report that blamed the failure to catch Bernie Madoff’s fraud scheme on widespread incompetence at the Securities and Exchange Commission, U.S. Senator Charles E. Schumer (D-NY) announced Thursday that he is drafting legislation to allow the agency to keep all of the fees it collects so it can afford to recruit and retain better-trained personnel.

Schumer’s proposal, to be introduced when Congress returns to session next week, would, on average, bolster the SEC’s budget by hundreds of millions on an annual basis, enabling the agency to attract professionals with the expertise required to uncover complex financial fraud. In recent years, the size of the financial markets has grown rapidly while the SEC’s budget has remained essentially flat. The new funding scheme Schumer is proposing would treat the SEC in the same way as Federal Reserve and the Federal Deposit Insurance Corporation, both of which are funded through fees it collects from institutions it oversees.

SEC Chairman Mary Schapiro has already signaled her support for Schumer’s proposal.

“The SEC’s failure to catch Bernie Madoff shows a level of incompetence unseen since FEMA’s handling of Hurricane Katrina. It is clear the SEC needs a bigger, more reliable funding stream so it can retain and recruit the top talent that has fled the agency of late,” Schumer said. “Under the current system, the agency’s rank-and-file personnel are struggling to keep up with the more sophisticated actors in the market. We cannot keep starving the SEC’s budget or the agency will remain a shadow of its former self.”

Schumer’s proposal comes after the SEC released a damning report by the Inspector General yesterday. According to a summary of the report, the SEC had enough evidence against Madoff to merit an investigation into the dealings of his investment firm, but the agency simply didn’t see what was happening right in front of them. The report repeatedly cites the lack of experience and expertise of the SEC personnel assigned to investigate Madoff, finding that they “failed to appreciate the significance of the analysis” in the complaints about Madoff and “failed to follow up on inconsistencies.”

Schumer said the agency’s ability to retain experienced personnel is an ongoing problem since Wall Street firms are increasingly able to lure the agency’s experts with higher salaries. Schumer said the SEC’s chronic under-funding must be addressed in a comprehensive way. Currently, the SEC raises millions more dollars every year in registration and transaction fees (not including enforcement penalties or settlements) than it is allocated through the appropriations process, but its budget is limited to the amount approved by Congress. In 2007, though the SEC brought in $1.54 billion in fees, it secured just $881.6 million in funding. Had the agency simply been able to hold onto all the fees it collected, it would have represented a 75 percent increase over the budget it was allotted through the appropriations process.

The SEC is one of only two financial regulators in the U.S. that must go through the annual Congressional appropriations process. U.S. banking regulators such as the Federal Reserve and the FDIC, on the other hand, can use what they collect in fees, deposit insurance and interest income to fund their operations.

Under Schumer’s proposal, the SEC will fund its own operations by using the transaction and registration fees it collects in place of a Congressionally-mandated budget. Self-funding will give the SEC access to millions more than is allocated through the Congressional appropriations process. Shapiro has suggested that hiring hundreds of new employees over the next few years for the Division of Enforcement and the Office of Compliance, Inspection, and Examination will give the SEC the human and technological resources it needs to keep up with a vast and expanding market.

The SEC’s staff of approximately 3,650 oversees 35,000 entities. Securities trading volume has increased 261% between 2003 and 2008, but the SEC staff grew only 15% over that period of time. The number of registered investment advisors has grown by 47%, and the assets they manage have increased by 105%. Meanwhile, the SEC examination staff charged with overseeing this portion of the financial system has grown by only 13% in that same time. The number of tips and complaints received by the SEC has increased by 146%, but the enforcement staff has expanded by only 23%. The SEC does not have the technology to track such a large market with so many players, and currently the SEC has limited capabilities to analyze data and identify market and trading risk.
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Bart Mallon, Esq. runs hedge fund law blog and has written most all of the articles which appear on this website. Mr. Mallon’s legal practice is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund. If you are a hedge fund manager who is looking to start a hedge fund, please call Mr. Mallon directly at 415-296-8510.

With all of the talk recently about the Madoff scandal and various other ponzi scheme’s affecting the hedge fund and investment management industry, we have decided to post a definition of a Ponzi scheme. The definition below comes from the SEC and can be found here. Continue reading →

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